20VC Semil Shah on How To Raise An Institutional Venture Fund, Why LPs Mostly Have Reserve Allocation Theory Wrong & Why IPOs and Acquisitions Are Severely Constrained

In this episode of "20 minutes VC," Harry Stebbings interviews Semil Shah, the founder of Haystack, an early-stage investment firm boasting a portfolio with companies like Instacart and Doordash. Semil, also a venture partner at GGV Capital, shares his journey from writing about tech to becoming a sought-after investor, with industry heavyweights like Mark Andreessen recognizing him as a tech rock star. He discusses the intricacies of raising institutional capital for his fourth fund, the importance of building LP relationships, and the strategies behind successful fund allocation and reserve policies. Semil also touches on the challenges of scaling investments in hot rounds and the evolving landscape of liquidity for early-stage ventures, highlighting the need for adeptness in navigating secondary markets.

• Semil Shah is the founder of Haystack, an early-stage investment firm.
• Haystack has a notable portfolio including Instacart, Doordash, Giphy, and Opendoor.
• Semil is also a venture partner at GGV Capital.
• He has consulted for prominent venture capital firms such as Kleiner Perkins, DFJ, and General Catalyst.
• Semil has a media background, contributing to TechCrunch and Harvard Business Review.
• He is recognized by industry leaders, with Mark Andreessen naming him one of his 55 unknown rock stars in tech.

"Yes, I'm delighted to welcome Semil Shah to the hot seat today. Now Semil is the founder of Haystack, an early stage investment firm with a star studded portfolio including the likes of Instacart, Doordash, Giphy, Opendoor and managed by."

The quote introduces Semil Shah and his firm Haystack, highlighting its successful portfolio and Semil's notable roles in the venture capital ecosystem.

• Semil Shah transitioned into venture capital from working at startups and writing on his blog.
• His writing and use of Twitter attracted attention from the startup ecosystem, leading to engagement with investors.
• Semil's insights led to consulting roles with venture capital firms.
• He credits venture capitalists for encouraging him to start his own fund, which became successful.

"And actually, it was a lot of vcs that put me, they wouldn't hire me, but they would put me in business with a little small fund. And I got very, very lucky in that first fund, and I think things started to accumulate from there."

Semil Shah explains how venture capitalists supported him in creating his own fund, which marked the beginning of his success in venture capital.

• Managers seek institutional capital for several reasons.
• Institutional capital is seen as a progression in the growth of a fund.
• It can enhance a fund's brand and stability.
• Institutional investors often provide long-term capital, reducing fundraising frequency.
• Relationships with institutional investors can lead to co-investment opportunities and other collaborative benefits.
• Despite the allure of institutional capital, all capital sources are ultimately valuable if they align with the manager's relationships and strategy.

"I think three people who are going through these fundraise. It's very episodic when you're going with individuals or small families, and even though there's a bit of a process and a bit of formality, and it takes obviously a lot of time for the most part, when institutions come with you, they'll stay with you and think about you in a ten year lens almost."

Semil Shah discusses the advantage of institutional investors' long-term commitment compared to the episodic nature of fundraising from individuals or small family offices.

• New fund managers often aspire to attract top-tier institutional limited partners (LPs) without understanding the selection criteria and investment thresholds of these institutions.
• Institutions like Notre Dame and MIT are highly selective and typically do not invest in small, new funds.
• Institutional investors expect the risk of new funds to be outsourced to other LPs before they consider investing.
• Building relationships with institutional LPs should be a strategic and realistic process, recognizing the need to establish a track record before approaching top-tier institutions.

"So let me answer that in reverse. I think a lot of people I'm meeting today are raising their first fund ever, and they want an intro to MIT in Notre Dame. And what they don't realize is Notre Dame may not have invested in a new fund in about two years."

Semil Shah emphasizes the unrealistic expectations of new fund managers seeking investment from prestigious institutions without prior experience or a significant fund size.

• Top venture capitalists (VCs) often have vast amounts of capital at their disposal.
• For these VCs, considering smaller investments may not be worth their time.

"at the top have hundreds of millions allocated to the best vcs in the world. It's not even worth their time to consider it."

This quote emphasizes the scale of investment top VCs manage, suggesting that smaller deals are not their focus due to the large funds they oversee.

• Establishing connections with VCs can be beneficial.
• The quality of an introduction matters; a respected mutual connection can make a significant difference.
• Cold outreach without a natural connection may be a waste of energy.

"if somebody that they know respects says, hey, you should meet Sally, or, hey, John has sent us four deals this year and we did two of them. They kind of say, okay, let's go put this person on our radar."

This quote highlights the importance of having a respected intermediary to facilitate introductions, thereby increasing the likelihood of gaining attention from busy VCs.

• Raising funds is not seen as an accomplishment but rather the beginning of the responsibility to deploy capital effectively.
• There is a sense of paranoia associated with ensuring the proper use of the raised funds.

"I don't personally think of it as an accomplishment. I'm more now consumed with the paranoia of how to deploy it properly."

The speaker expresses that their focus is not on the success of raising funds but on the pressure to invest those funds wisely.

• Premarketing involves informal interactions and building awareness before the formal fundraising process begins.
• It's likened to creating buzz for a movie before its release, using casual conversations and reminders to keep potential limited partners (LPs) engaged.
• Premarketing should start well in advance of the actual fundraising—six months or more is recommended.

"The pre marketing is just the casual reminder. The casual, hey, here's what I'm doing. The casual, hey, what do you think about this?"

This quote defines premarketing as a series of informal, strategic communications aimed at keeping potential investors informed and interested in the upcoming fundraising efforts.

• Being open and seeking feedback from potential investors is advised.
• Transparency can help in finding alignment and receiving valuable insights.

"I can only say what I did, which is just be super open and look for feedback and try to triangulate."

The speaker advocates for openness in fundraising discussions, suggesting that this approach aids in gathering useful feedback and finding common ground with potential investors.

• Taking detailed notes and refining fundraising materials based on feedback is crucial.
• It's important to discern which feedback to implement and which to discard, especially considering the varying levels of market proximity and expertise among LPs.

"I took notes. I kept refining, I kept showing them like a page that we could just kind of draw on together and then kept refining that work."

This quote underscores the iterative process of refining fundraising materials based on LP feedback, highlighting the importance of collaboration and ongoing improvement.

• A master slide deck should be created and then condensed into a shorter version for email distribution.
• Materials need to be easily shareable and concise to facilitate dissemination among potential investors.

"The deck is going to be passed around. It's going to be passed around to the person you send it to, their colleagues, their friends, the lps that they co invest with. So make it easy for them to pass it around."

This quote explains the rationale behind creating a concise and shareable deck, emphasizing the importance of ease of distribution in the fundraising process.

• There is a debate over the openness of sharing fundraising decks.
• Being brief, direct, and using PDF format is recommended for communication with potential investors.

"I think being brief, direct tactical with PDF works best."

The speaker suggests that concise and direct communication, particularly with easily shareable PDF files, is the most effective way to engage with potential investors.

• Preferring conversational engagement over formal presentations.
• Using an iPad or iPhone to share specific slides during conversations enhances the social and interactive aspect of meetings.

"I'm an audio learner. I'm a conversational learner. I converse by nature. I want to get to know the other person."

This quote reflects the speaker's preference for a conversational and personal approach to fundraising interactions, favoring direct dialogue over formal presentations.

• LPs are interested in past performance, deal sourcing, check size, ownership percentages, co-investors, and proxies for real results.
• Fundraising materials should highlight these core elements to address LPs' primary concerns.

"They certainly want to know previous performance. And just like the basic numbers, they want to know fund by fund, where things are tracking."

The speaker lists the key information that LPs typically seek when evaluating a fund, indicating that these details should be prominently featured in fundraising materials.

• Proxies such as who follows your deals and the amount of money put behind those deals are traditionally used to evaluate seed investments.
• There is skepticism about whether these proxies are correlated with actual investment results.
• The next few years may challenge the validity of these traditional proxies.

"And the proxies in seed are who follows your deals, how much money is put behind those deals? Can you continually do that? Can you intercept the good deals? The problem with all that that we're going to go through probably in the next three or four years is those may not be correlated with results."

This quote underlines the uncertainty surrounding traditional metrics for assessing seed investments and foreshadows a potential shift in evaluation methods over the coming years.

• Scaling check size is a significant concern when transitioning from smaller to larger investment funds.
• Sophisticated limited partners (LPs) focus on the ability of investors to consistently invest larger amounts in high-quality companies.
• The challenge lies in maintaining investment quality while increasing the monetary size of investments.

"How are you going to consistently put 750 to a million dollars in a great company?"

This quote reflects the pressure on investors to demonstrate they can scale their investments without compromising on the quality of the companies they choose to back.

• Reserve strategy is a key consideration for investment funds, and it evolves with each fund.
• Demonstrating a history of scaling check sizes appropriately is crucial.
• There is a debate on whether traditional VC reserve strategies apply to seed investing, which is considered a different asset class.
• Seed investing may require a different approach to ownership and reserves compared to later-stage investments.

"I think the majority of LPs have taken the history of how VCs, institutional VCs, A, B, and C reserve and bolted that onto seed, whereas I think seed is a completely different asset class."

This quote challenges the conventional wisdom on applying reserve strategies from later-stage investing to seed investing and suggests that seed investing requires a unique approach.

• Setting a specific raise date helps control expectations and mental health during the fundraising process.
• Committing to a strict range of investment and a six-month timeline can provide peace of mind.
• The discipline of adhering to self-imposed limits is beneficial, even if luck plays a role in fundraising outcomes.

"I told people I was going to stick within a range. I wouldn't take a dollar more than the top end of that range."

This quote emphasizes the importance of self-imposed discipline in the fundraising process to manage expectations and mental stress.

• There is a belief that funds over $40 million require intense focus on ownership to be successful.
• The changing market conditions mean that aggressive growth fueled by capital may not be sustainable.
• Investors need to be cautious about promising too much to LPs and deviating from their successful investment strategies.

"I am sort of of the paranoid belief that in any vehicle, if you have over $40 million, you have to be so laser focused on ownership, regardless of how many GPs you have in order to have a really good fund."

This quote expresses a cautious approach to fund size and the need to concentrate on ownership stakes to ensure fund success.

• The traditional exit strategies for VC investments, IPOs and acquisitions, are becoming less common.
• Early-stage investors need to adapt their strategies to facilitate liquidity, potentially through secondary markets.
• The decrease in the number of publicly listed companies and changes in acquisition behavior by tech giants are contributing to this shift.

"We're going to have to get really, really good at understanding of how to settle in secondaries and when."

This quote highlights the need for early-stage investors to become adept at navigating secondary markets to achieve liquidity for their investments.

• The secondary market is a taboo topic because it confronts the harsh realities of the current investment environment.
• Investors who achieve significant valuation increases in their portfolio companies may need to sell portions of their positions to realize gains.
• Managing the amount of money in a pooled vehicle is crucial to enable such strategic sales.

"It's taboo because it's reality."

This quote suggests that the reluctance to discuss secondary markets stems from the discomfort of facing the current challenges in achieving liquidity for investments.

• Semil Shah shares his experience of raising his first 2nd fund by approaching people he knew, like founders and VCs he had worked for, and collecting smaller checks.
• He observes that many people aim too high initially, trying to secure funds from top-tier investors without building a foundation first.
• Semil emphasizes the importance of going through the foundational steps of fundraising before aiming for the major league investors.

"I just went to people I knew like founders, I've backed VCs that I worked for and would literally be collecting ten k checks, 25k checks, still took some ten k checks in this fund from people I know."

The quote underlines the grassroots approach Semil took in fundraising, starting with his immediate network and securing manageable amounts of investment.

• Semil Shah admits that he has shifted from reading books to listening to podcasts due to time constraints.
• He prepares for the interview, knowing the host's tendency to ask about favorite books.

"I used to be a voracious reader, but once I started this fund and then have kids, I do not read books, but I voraciously listen to podcasts."

Semil explains his current preference for podcasts over books, attributing the change to his busy lifestyle.

• Semil believes that placement agents are not suitable for early or unproven funds.
• He suggests that building relationships personally is crucial for smaller funds.
• Placement agents become relevant for established funds with oversubscription and a track record of returning capital.

"If you're an early or unproven fund, early-stage manager, smaller fund, it just doesn't make sense."

The quote highlights Semil's opinion that placement agents are not beneficial for new or small fund managers.

• Semil discusses the reality that some investors will wait to see if a fund can raise institutional capital before taking it seriously.
• He compares this to established firms like Benchmark, who outsource early-stage investment risks.

"Some people simply will wait for you to raise an institutional fund before taking you seriously because they don't think you can raise it."

Semil shares his insight on investor behavior, noting that credibility is sometimes contingent on securing institutional funding.

• Semil finds value in revisiting older blog posts from influential VCs for guidance.
• He views VC blogging as a form of mentorship and apprenticeship in the industry.

"I'll go back into the AVC catalog or a bookmark from Fred. And I almost feel like Fred is mentoring me through his blog."

Semil acknowledges the impact of Fred Wilson's blog (AVC) on his professional growth, treating the content as virtual mentorship.

• Semil praises three first-time fund managers for their approach to raising funds.
• He highlights Homebrew's relationship-building, Avidon, Ross, and Kane's passion, and Lux Capital's persistence over a decade.

"The founders of Lux Capital. Everybody knows Lux now, and they've been oversubscribed many, many times, but literally for ten years or plus had really hard time raising funds."

The quote illustrates the long-term effort and eventual success of Lux Capital in fundraising, serving as inspiration for new fund managers.

• Semil shares his investment in Ironclad, emphasizing his focus on investing in people rather than specific sectors.
• He values the drive and obsession founders have for their ventures over the market they operate in.

"I invest in the sector where people are insanely driven and obsessed with what they're doing."

Semil explains his investment philosophy, which centers on the founders' passion and dedication rather than the industry.

• Harry Stebbings expresses appreciation for Semil Shah's participation in the show and promotes his Twitter and website.
• The show promotes First Republic's services for startups and Segment's data integration platform.

"And a massive congratulations in scaling up to introducing institutional capital into the fund."

Harry Stebbings congratulates Semil Shah on the growth of his fund, Haystack, and its progression toward institutional funding.